Are You In the Retirement “Red Zone”? Basic First Steps You Can Take To Prepare For Retirement
Do you hear people talk about being in the financial “red zone” and wonder what this means? The “red zone” is often referred to as those critical savings years, just before retirement.
Are you looking for ways to prepare for retirement? As a financial advisor and former CPA, I work with clients by preparing financial plans that help them meet their financial goals. The biggest concern I hear lately is, “how do I save more for retirement?”
I usually recommend that you first maximize your 401K contribution, which in 2013 is very substantial. An individual 50 or older (think flashing “red zone”) can contribute $23,000 in pre-tax savings to a 401(k) or 403(b). It is very important to realize that when you contribute on a BEFORE TAX basis, the contribution is costing you much less than the contribution amount would equate to in after tax dollars. So if you are a high income earner (i.e., highest federal tax bracket of 39.6%) and assuming a 5% state income tax rate, the amount of after tax dollars forfeited to contribute $23,000 is approximately $13,200. Hopefully this makes simple and clear sense to you.
Step 1: MAXIMIZE your before tax savings!
Now, for the part most clients are not aware of, consider also maximizing your after-tax contributions to your 401(k) or 403(b). More than 50% of 401(k) plans today allow participants to make after-tax contributions. This will allow you to set aside more assets that have the ability to grow on a tax-deferred basis and as a way to accumulate assets that may be more tax-advantaged when distributed in retirement. These after-tax contributions can become a source for a potentially tax-efficient Roth conversion which allows you to gain more flexibility in managing your tax liability in retirement. In essence, making after tax contributions to your 401(k) provides you with a tax-efficient way to bulk up your Roth assets.
If your plan allows for after-tax contributions, you may be asking, “aren’t there restrictions on the total amount I can contribute to my 401(k)?” Yes, your after-tax contributions combined with your employee salary deferrals (the $23,000 discussed above) and employer contributions for 2013, in total, cannot exceed $56,500 for those ages 50 and older. Your after-tax contributions may be further limited by the plan document and/or to meet certain nondiscrimination testing requirements.
Step 2: MAXIMIZE your after-tax savings!
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax. Future laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. LPL Tracking #1-163721
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